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Ulta Beauty Inc(ULTA-Q)
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Buy These 2 Growth Stocks on the Dip

Motley Fool - Thu Sep 21, 2023

As the market heats up, it's harder to find great bargains. But there are always top stocks the market underestimates, and those are often the best places to put your money to work. Ulta Beauty(NASDAQ: ULTA) and Revolve Group(NYSE: RVLV) are two excellent picks that are down in 2023 but could supercharge your portfolio for years.

1. Ulta: High sales, challenging margins

Ulta took the beauty world by storm with its novel concept of combining cheap and expensive beauty, haircare, and skincare products under one roof. It also differentiates itself by offering services like hair and makeup, which increase engagement and generate higher sales. Although Ulta's been in operation for more than 30 years, there's yet to be a competitor that offers the same model, and Ulta has carved out this specialized niche for itself.

But it's more than a niche, which might imply a small opportunity. The model it's perfected opens it up to all consumers, from mass market to upscale shoppers, creating a huge target market for the company.

This has led to increasing revenue as well as profits as it has scaled. Even under these challenging market conditions when many retailers have struggled to overcome high inflation, supply chain shortages, and more, Ulta continues to expand its presence. Customers may switch down to lower-priced products, but they can still find them at Ulta.

Revenue increased 10% year over year in its fiscal 2023 second quarter (ended July 29) with 8% comparable-sales growth. Earnings per share (EPS) climbed 6% to $6.02. However, both gross margin and operating margin contracted. It hasn't been easy to properly balance inventory levels while taking into account rising costs and strong demand. Compared to the prior-year quarter, gross margin narrowed from 40.4% to 39.3%, and operating margin shrank from 17.0% to 15.5%.

Management raised the full-year outlook for sales, comps, and EPS, and it even raised operating margin guidance after cutting it in the first-quarter report. It wasn't enough to please investors, though, who were looking for more improvement, and the stock sold off like it did after the first-quarter report.

Ulta stock is now down 12% so far this year, and at this price, shares trade at just 15 times forward one-year earnings. That's an incredible bargain for an industry leader with years of long-term growth potential.

2. Revolve: The AI answer to online fashion

Revolve Group operates a digital fashion website that was growing quickly and profitably until a year ago. It targets millennial and Gen Z consumers with trendy fashion, and in the case of its sister site FWRD, high fashion. It works with influencers and celebrities through social media, and although it's an all-digital enterprise, the company hosts several festival-style fashion events where it builds relationships with its clientele.

The artificial intelligence (AI) part means that its systems, which have all been built from the ground up with AI, can identify changing trends quickly and manage inventory to meet demand. This approach results in higher sales at full price and a reduced need to mark down items. This is particularly true since Revolve mostly works as a reseller of other designer partners and can plan for smaller capsules. It has also branched into owned brands, which are ultimately better for the bottom line but difficult to plan for in a challenging shopping climate. It's taking a careful approach here, but this could be a growth driver under the right circumstances.

The number of active customers continues to increase despite revenue and profit declines -- it was up 14% year over year in the second quarter, illustrating Revolve's relevance and opportunity.

Otherwise, the current situation isn't inspiring. Revenue decreased 6%, and net income was down 55% last quarter. But management is still on the offensive. Co-CEO Mike Karanikolas said in a statement, "Challenging operating environments create opportunities for financially strong and cash-generative companies like REVOLVE to further separate from the pack by continuing to prudently invest through the cycle." With its strong cash position, Revolve is setting itself up to resume high growth in a better economy.

Investors have soured on Revolve, and the stock is now down 43% year to date. At this price, it trades at 18 times forward one-year earnings. This is an excellent entry point for a stock that could soar when the economy rebounds, and management signaled its bullish outlook by announcing a $100 million share repurchase program last month.

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Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Revolve Group and Ulta Beauty. The Motley Fool has a disclosure policy.

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